Professor: "I really have no way of figuring out what a bitcoin is worth."

Bitcoin’s biggest asset is also its biggest liability—no government or regulator controls what people are willing to pay for a little piece of nearly-anonymous computer code. That fact may partially explain why the price of one bitcoin has shot up in recent days and weeks, only to come crashing down again on Wednesday.

On Thursday, Bitcoin’s largest exchange, Mt. Gox, suddenly suspended trading for 12 hours as part of what it described as a “market cooldown.” That pause is set to end at 9:00pm CT on Thursday evening.

It certainly doesn’t help matters that there’s new Mt. Gox-lookalike site serving malware. Also on Thursday, entrepreneurs Cameron and Tyler Winklevoss told the New York Times that they hold approximately 1 percent—roughly $11 million—in bitcoins. In short, Bitcoin may be poised to rise even further, or crash even deeper and faster than ever before.

Ars contacted three major investment banks to inquire if they had any bitcoin holdings—Goldman Sachs, JP Morgan Chase, and Credit Suisse.

“We have no comment,” said Andrew Williams, a spokesperson for Goldman Sachs. JP Morgan Chase and Credit Suisse did not respond.

Some say that the recent rise of more advanced bitcoin-related financial services, including hedge funds, futures, and derivatives markets, could help stabilize the future of Bitcoin. This week, a soon-to-launch New York-based “leveraged forex trading platform” for Bitcoin, called Coinsetter, announced that it had received $500,000 in venture capital.

“In general, derivative markets tend to make prices more stable rather than less,” Eli Dourado, a research fellow at the Mercatus Center at George Mason University, who studies Bitcoin, told Ars. As evidence of this, he cited the fact that the United States has banned onion futures since the 1950s, and the price has been volatile ever since as a result.

“An ability to bet that it is a bubble can help to tame the bubble,” he added. “You can bet against the price increase. That said, I think that bitcoin is still going to be really volatile. This isn't going to fix that problem.”

Others are less than convinced of the crypto-currency’s bright future—derivative markets or no.

“It’s play money in the virtual casino,” said James Angel, a business professor at Georgetown University. “Everybody else is trying to outguess each other. Bitcoin has turned into a very large multiplayer online game in which everybody is trying to out speculate each other.”

The Maltese Falcon, aka, the Bitcoin Fund

These new ventures and derivative markets have a variety of names, including Exante’s Bitcoin Fund, ICBIT.se, and even TorBroker, a Silk Road-style “hidden website” that requires Tor to make stock trades.

Exante is likely the most bona fide of these operations as it is an official, licensed, Malta-based brokerage company with a real office, real employees, and the power of European Union regulators behind it. Earlier this year, its “Bitcoin Fund” became the world’s first bitcoin-based hedge fund and is based in Bermuda, a notorious offshore tax haven.

“Similar to Exchange Traded Funds, the Bitcoin Fund objective is to purchase and store BTC; 1 Bitcoin Fund Unit = 1 BTC,” the site states. “The investment objective of the Fund is to achieve capital gains in the Net Asset Value of the Fund Shares. The fund currently manages a portfolio of 81,000 BTC and has achieved a phenomenal +1000% return in its short 3-month history.”

Reached by phone in Singapore, Anatoliy Knyazev told Ars that the “Bitcoin Fund” was a “nice addition” to the mix of existing funds and other financial transactions that the company offers. Americans, due to existing regulations, can’t invest in the Bitcoin Fund just yet, but a “feeder fund” is set to be ready in a few months.

“We have alternative funds that invest in wine, real estate,” he said. “Bitcoin as a share of our business is growing but it's [still small.] We have 82,000 BTC in the fund—today that’s almost $20 million. To compare it with the rest of our business it might be trickier. Our hedge fund market is about $2 billion. What's important is the amount of return that we get from Bitcoin. In January we had subscriptions, we tried pitching Bitcoin last summer and autumn with mixed results. After the price appreciation in January from 10 to 20 [dollars per bitcoin] we were overwhelmed with people wanting to get in.”

Knyazev added that his investors were other hedge funds and “high net-worth individuals.”

“Let’s say you invest $1 million, and from that we purchase bitcoins. You're issued the fund shares, so you get 100 shares. After that we take custody of them, geographically distributed, cryptographically secured. The encrypted flash drive copies [of the Bitcoin wallet itself] are kept in bank safes [in Moscow, Singapore and Switzerland.]”

Shorting bitcoin

But while Exante may be the best example of what’s out there in terms of bitcoin-based investments, there’s also some pretty sketchy stuff too.

Alex Stukalov is one of the “roughly four people” behind ICBIT.se, a Russia-based site, who operates under the shared handle “fireball.” ICBIT has been in operation since November 2011, boasting 5,000 registered users, with “around 100” online at any given time.

Stukalov, who spoke to Ars via Skype text chat, said that a well-known Bitcoin user in Vietnam named named “Tycho” (who has also been publicly accused of “cheating” the entire Bitcoin network) receives some of the revenue from the site and acts as a consultant. He claims that in six months, the team has taken in roughly 2,000 BTC in revenue (approximately $300,000 at $150 per bitcoin). But, he says, all that money has been put straight back into the company.

“The profit inflow is not really that stable. Even more, we put all money currently taken from fees into the so-called ‘reserve fund,’ which should cover exchange from default,” Stukalov said. “And currently, during recent rate volatility, that reserve fund was heavily exhausted.”

“The best statistics [are] the total volume and open interest (quantity of contracts currently bought/sold). So, counting in dollars (1 contract = $10), total volume for all three contracts for the recent three months is $1.4 million.”

ICBIT is one of the few places on the Internet where investors can engage in a futures market, effectively betting on the upcoming exchange rate from bitcoins to dollars. On its site, it also says: "ICBIT currently is in process of incorporating in an offshore jurisdiction. If you are a lawyer willing to help us - please let us know, we need your help."

Ars spoke to three traders on the site on Thursday afternoon, who identified as a Dutch business student, a Los Angeles-based IT manager, and a French scientist who recently finished his doctorate in bioinformatics and was headed to a new job in Brazil in a few months.

Simon Gorter, the Dutchman who goes by the online handle “chipsticky,” told Ars that he had only bought 0.6 BTC “a few days ago” and used it to “short a position,” effectively betting that fraction-of-a-bitcoin’s exchange rate would go down. In just a few days, he claims to have tripled his money to 1.8 BTC, currently worth roughly under $300.

“I’m still a student,” he added “I do online poker as well, but just got interested in this Bitcoin hype and looked at the charts and realized how crazy it was. Sure, I’m trying to profit, but just for small money. It’s more like a game for me, to see if I am right about the market.”

When asked if he was “long” on bitcoin—believing that its value will increase over time—he had a decided answer.

“I’ve thought about it a lot last few days, and I came to the decision that its a bubble that will burst,” the University of Groningen business student said. “The question is, how high can it go before it does? I think there is a good chance it already did and will drop even further. Another possibility is that the mainstream media has brought a lot of interested people willing to buy a few coins which could cause another boom going way higher than the last high before the bubble will burst.”

The Los Angeles-based trader, who goes by the online handle “bV” openly accused Stukalov and the others behind the site of “manipulating” the future price in the middle of a given futures contract.

“I figure my only recourse is to just going to keep buying until I run bust and stick the exchange with the debt,” he said, noting that in the worst-case scenario, he would lose his original investment of $1,000. “Since I can't get my money out, I can at least bet on a quick recovery!”

Stukalov dismissed such allegations, saying that they followed norms for futures markets.

“We do stuff the right way,” he said. “We have several people with background in finances and stock market trading participating in ICBIT development, we know how to do it really properly, not amateurish. And we stick to what we say (it's even obvious from the ratio: there are about three upset people now, out of 5,000 registered, and around 3,000 trading)”

But, ICBIT has no listed legal address, nor a listed mechanism through which to adjudicate disputes. Plus, it wouldn't be hard to imagine a scenario where someone shorts Bitcoin, then launches a distributed denial of service attack on Mt. Gox or another exchange, causing chaos in the market, and likely, profiting.

How do you value one bitcoin, anyway?

The reliability of bitcoin-related businesses is precisely that problem. Hardly anyone in the world gets paid in bitcoin, and hardly anyone is selling goods in bitcoin. Sure, you can buy stuff from Bitcoinstore.com or any other similar site, but nearly all goods there are based on exchange rates with traditional currencies.

“Even if there is a speculative element [with traditional commodities], at the end of the day you expect the price to have a gravitational pull towards the true value," James Angel, the Georgetown professor, added.

"We have models for valuing stocks and bonds, so we can get a sense of what it’s worth. But I really have no way of figuring out what a bitcoin is worth. Sure, I can go to exchanges and see what the current price is, but how do I know that that price tells me anything? If I look at the price of the euro, I know what I can buy with euros. I know how many euros it takes to get a Big Mac in Paris or a hotel room in Frankfurt. We have this idea called ‘purchasing power parity’ that says that sooner or later exchange rates should reflect prices across different exchanges. We don’t have that with bitcoin.”

Plus, he added, traditional commodities like gold, oil, wheat, and others have practical value beyond their monetary value. Gold can be used as jewelry, or manipulated industrially to manufacture semiconductors. Oil can be used to power machinery or refined for gasoline. Bitcoins have zero inherent utility.

“The demand for bitcoins can be driven by either its usefulness as a medium of exchange or a store of value,” Irfan Emrah Kanat, a doctoral student studying virtual currencies at the W. P. Carey School of Business at Arizona State University, told Ars. “Bitcoin is not accepted on Amazon or in the corner store, so its use as a medium of exchange [is] limited.”

And sure, if you take the opinion that bitcoin is more like a fiat currency (like the US dollar), which isn’t based on anything either (we went off the gold standard decades ago), it has a massive infrastructure designed to regulate and safeguard its function as a currency through institutions like the Federal Reserve, the Treasury Department, the Securities and Exchange Commission, the Commodity Futures Trading Commission and other entities.

“The bank that is storing my money is highly regulated by federal regulators and backed by a government with a huge army behind it,” Angel added.

Cyrus Farivar
Cyrus is a Senior Tech Policy Reporter at Ars Technica, and is also a radio producer and author. His latest book, Habeas Data, about the legal cases over the last 50 years that have had an outsized impact on surveillance and privacy law in America, is due out in May 2018 from Melville House. He is based in Oakland, California. Emailcyrus.farivar@arstechnica.com//Twitter@cfarivar

140 Reader Comments

If the other bitcoin exchanges (which haven't closed) are any indication, and there is no reason they shouldn't be, mount gox will probably reopen at around 80 USD per bitcoin. Given that this is another 30% percent below the last price on Mount gox, I expect the bout of panicked selling to continue.

Derivatives (and the exercise of options) are likely a good method for pursuing a more stable long-term market for Bitcoins (by positioning those bullish and bearish on the virtual currency as competing interests), but their limited utility may make even these more sophisticated instruments speculative at best. After all, like the article says, we know what commodities are good for, we know what bonds are good for, we even mostly grasp the concept of what we get with an equity position. But Bitcoins? Not as clear-cut.

I can't believe someone said with a straight face that derivatives make the market less volatile. Sure, they might have in the 60s and 70s, but with today's super exotic products and high speed trading, all they really do is cause wide, inexplicable price swings.

I can't believe someone said with a straight face that derivatives make the market less volatile. Sure, they might have in the 60s and 70s, but with today's super exotic products and high speed trading, all they really do is cause wide, inexplicable price swings.

And can fix said price swings just as quickly. Would you rather, in a high volatility event (which can, shock of shocks, be exogenous), have a system where an attempt to re-establish an equilibrium between bids and asks happens quickly or slowly?

While I will never convert my dollars to Bitcoins, I have been mining them on and off over the past two years. They have even been able to pay off a few coffees and dinners here and there. It's a fun way to make a bit of money off of the idle power of my graphics card.

Bitcoin's utility lies in the fact that they are potentially an effective substitute for cash for certain transactions. But, as a potential investment, they are certainly meant for digerati with a greater faith in technology and humanity than actual sense...

I can't believe someone said with a straight face that derivatives make the market less volatile. Sure, they might have in the 60s and 70s, but with today's super exotic products and high speed trading, all they really do is cause wide, inexplicable price swings.

Very complex derivatives, which is to say difficult to calculate the expected outcome from market value, can create problems via their own instability. However straightforward derivatives do indeed tend to work against bubbles.

On the other hand derivatives make it much easier to profit from market down swings. This makes it much easier to profit from market manipulation that causes crashes. Given BTC's fragility that opens the door wide to some very nasty and shady times ahead.

Question: how is a bitcoin converted into tangible currency? Say I own a own a bitcoin. How do I sell it for dollars? Who is the clearing house that handles the actual cash transaction?

For that you'll have to use an exchange site and wait for someone to buy your bitcoins that are on sale. Kinda like a stock market. MtGox is the biggest site but there are others, googling "bitcoin exchange" should give you alternatives.You can also try and talk to someone into buying it for real money, so they'll do that instead of you

You can sell BTC for dollars by finding someone who wants to use dollars to buy BTC. In addition to the big exchange sites like MtGOX, there are individual money changers and smaller ad services who can give you contact information for those money changers. Most of these services also offer an escrow service for a little more security. You put your money in the escrow wallet. The one you are trading with puts their money in the escrow wallet. When you are both satisfied that the trade is fair, you exchange escrow wallets and claim your money.Here is the Wiki page on "How to sell BTC". At the bottom of the list is one of the money changer referral services http://localbitcoins.com/ (This is NOT an endorsement, I simply found them a few months ago when searching for an answer to the same question...I have NOT used this service so cannot make any comment on usability or safety)

Now that you mentioned it, as soon as I started reading I went to that Bitcoinstore site, BTC was valued at 93US$. Right now, it's 77.50US$. Seller panic at its best

And now it's up to $100.01 on Bitstamp. Whee...

I find Bitcoins fascinating conceptually, and the idea of virtual, non-government currencies potentially world-changing, but there's no way in hell I would put my savings into Bitcoins right now.

Also, given the variations in prices on different sites, it seems like there would be a huge (and, of course, hugely risky) opportunity for arbitrage...

Even on Mt.Gox, the most liquid of exchanges, there are opportunities for arbitrage between currencies compared to those currencies on normal currency exchanges. I checked a few and found 5% discrepancies. If you already have accounts in both of the currencies and can live with shifting between them, or just want to shift between the currencies anyway in the favourable direction, that should give enough margin to work with most of the time.

EDIT: Mind you that is small potatoes compared to the 15% gap between bitstamp and MtGox with US$/BTC that is happening right now.

I'd be curious to know what type of financial standards (if any) Mt Gox has to meet. If they are coordinating payments, then they have to plug into the global financial system. The site is currently DDoS'ed, so I can't read their info.

I'm completely fascinated by parallel to the Tulip Mania of the 1630's, except in that case, there was a tangible object. Kudos to the people who got into the system early.

i wonder what will happen when someone forks the bitcoin, a bitmoney or whatever they called,it was already happening with an update of the bitcoin, but when someone do this on purpose?we will have tens or hundreds of forks? what will be the value then, zero.

As evidence of this, he cited the fact that the United States has banned onion futures since the 1950s, and the price has been volatile ever since as a result.

LOL Cyrus, I think you might have made your point better without referring to one of the most egregious examples of market-manipulation of modern times. An analysis like this one might be more convincing.

isn't investing in bitcoins same as investing in stocks? where stocks have a value of the company? whereas bitcoins depend on supply and demand?

Bitcoins are more commodity than stocks, as stocks you not only have a company and its assets, but its earnings and cashflow to back the paper. Bitcoins only have the value users (or speculators) of bitcoins attribute to them; for a while this was pegged to the cost of electricity for running a mining rig or farm, but with more people and more money, the prices rise because people are willing to pay more on the assumption that someone else will pay more than they did. It's just gambling in the same vein as day trading and options.

What is similar with traded financial products is that bitcoin exchanges basically have lots of orders hiding around different values and when someone offers to sell their bitcoins, it is either automatically fulfills a standing order someone has put out or if it is too high, then someone needs to meet that price; vice versa for buy orders. The recent tumult should be more attributed to idiots who were willing to pay so much on the way up petering out of enthusiasm.

I suppose increasnig media coverage of Bitcoin is making investors out of more and more people who think they know what they're doing.

The past few days have seen a bubble burst and several issues at different exchanges. Yet I've just checked MtGox and trading volume is spiking right now. Is someone short selling these and riding the crash?

Anyway, the electricity used to generate a bitcoin is a sunk cost. It limits supply but it's in no way equivalent to assets or cashflow of a currently trading company.

More importantly than being a sunk cost (because it isn't in the moment as new mining can be done), mining does not represent creation of wealth. Unlike real mining, the product of Bitcoin mining provides zero value to anyone outside the context of the currency itself (except the small arguable value of freshly minted, never-used-before coins being better for money laundering due to zero history in the block chain).

The term "mining" is really a misnomer economically speaking, an intentional one I expect. If not intentional, then it signifies gross economic misunderstanding by the architects of Bitcoin. What is called Bitcoin mining is really Bitcoin minting.

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LOL, priceless that this pyramid scheme spam shows up in this thread...

The bitcoin market is 100% opaque. Bitcoins are a complete mystery build on the concept of faith. The volatility evident should prevent all sane investors from getting involved. There are no mechanisms in place to prevent market manipulation so expect collusion as insiders make sham trades to elevate prices in order to suck in the rubes. At least worthless paper assets could be used as toilet paper.

The bitcoin market is 100% opaque. Bitcoins are a complete mystery build on the concept of faith. The volatility evident should prevent all sane investors from getting involved. There are no mechanisms in place to prevent market manipulation so expect collusion as insiders make sham trades to elevate prices in order to suck in the rubes. At least worthless paper assets could be used as toilet paper.

Not only that, but from my experience, the vast majority of use for Bitcoin breaks down into two illegal categories:

Oh really? The Credit Default Swap, the Collateralized Debt Obligation, the Synthetic CDO, Asset Backed Securitization were the instruments that allowed for the destruction of the entire worldwide real estate market in 2007 and 2008. Without those derivatives, there would be no Great Recession. End Of Story. Anyone who has read more than 5 or 6 books on the crash of 2008 understands this. It's like Great Recession 101.

Not to mention what the electronic trading of Oil has done. For decades, oil prices changed in relatively smooth curves over time. In the first decade of the 2000s, that all changed. Oil prices are now spiking and dropping like crazy. You can read books like The Asylum and understand why this is happening. Some of it is because of crazy uses of derivatives that are enabled by massive computers.

None of this was even possible when the economists were coming up with their theories of simple derivatives like futures back in the 70s. They don't understand the math they are dealing with (which is one of the things that happened in 2008).

2. The US dollar is well regulated

This is almost laughable. It was only 5 years ago that the entire US banking system had to be bailed out by the taxpayers, just like any other third world country. The idea that these banks 'payed back' their loans is just a flat out lie - just look at something like the AIG credit default swap situation with Goldman Sachs, where the taxpayer had to pay 100 cents on the dollar for something that was worth like 10 cents. There are literally zero people in jail for the CDS/CDO situation, which was the greatest ponzi scheme in history.

The CFTC is quite literally a bad joke. Let's take the first example, Brooksley Born ran the CFTC in the late 1990s wanted to do a study of Credit Default Swaps and other financial derivatives to see what effects they might have on the marketplace. As described in many places, including the PBS documentary on Frontline about her, she was 'character-assassinated' by Alan Greenspan, Larry Summers, and others in the Clinton administration who were free-market zealots. Obama re-hired some of these people in 2008 after Credit Default Swaps were at the heart of the crash. He didn't re-hire Brooksley Born.

Again the book The Asylum demonstrates another issue with the CFTC and all federal regulators - the revolving door between regulation and industry. The guy who ran the CFTC quit and went to work for the Nymex - the group that used to control the oil trading market, after helping CFTC make a decision that was favorable to Nymex. It is incredibly shady.

The US government is now 14 trillion dollars in debt. That is 14,000,000,000,000. If it were any other country, it would be under IMF protection and they would be dictating to us how to make our budget. We actually almost did go bust in 2008 when Russia threatened to call in the massive amount of US debt it holds, but China interceded (this is in Hank Paulsons book On The Brink. He was treasury secretary).

But because we are the 'reserve currency' we get a free pass. How much longer do you think that is going to last? The US political parties are unable to do anything about it - for the past 40 years they have been saying we need to control the debt but they both simply blame each other for the never-ending increase.

In light of these facts, bitcoin is, actually, in some ways, not that different from the other 'fiat currencies' of the world. It's not transparent - but neither is the US Federal Reserve, the SEC, etc. People have been threatened with legal action for simply trying to publish information about it that it didn't want out there. Bitcoin may be corrupt and a hedge-fund back alley game, but then again, a lot of world currencies are. Remember the Thai Bhat or the asian crisis of the late 1990s? A lot of that stuff is simply driven by hedge funders and their games.

The whole premise of bitcoin is that it's governance structure is somehow better regulated than the governments of the world.... well, its a sad fact, but it might actually be that way in the long run. Governments (including the US) are getting more corrupt as time goes on, not less.

Derivatives (and the exercise of options) are likely a good method for pursuing a more stable long-term market for Bitcoins (by positioning those bullish and bearish on the virtual currency as competing interests), but their limited utility may make even these more sophisticated instruments speculative at best. After all, like the article says, we know what commodities are good for, we know what bonds are good for, we even mostly grasp the concept of what we get with an equity position. But Bitcoins? Not as clear-cut.

When they say 'derivatives', they are not talking about options or futures. They are talking about something like Bitcoin Swaps, or Collateralized Securitizations of Bitcoin Swap Contracts, or other massively complicated organs.

You say "we know what bonds are good for". No, we don't. If we did, then the 2008 crash would never have happened - because that entire bubble was based on the inability of the banks and regulators to put a value on Mortgage bonds (as bundled into Mortgage Securities, which were rebundled into Collateralized Debt Obligations, which were rebundled into Synthetic Collateralized Debt Obligations based on Credit Default Swaps referencing other CDOs).

Oh really? The Credit Default Swap, the Collateralized Debt Obligation, the Synthetic CDO, Asset Backed Securitization were the instruments that allowed for the destruction of the entire worldwide real estate market in 2007 and 2008. Without those derivatives, there would be no Great Recession. End Of Story. Anyone who has read more than 5 or 6 books on the crash of 2008 understands this. It's like Great Recession 101.

Not to mention what the electronic trading of Oil has done. For decades, oil prices changed in relatively smooth curves over time. In the first decade of the 2000s, that all changed. Oil prices are now spiking and dropping like crazy. You can read books like The Asylum and understand why this is happening. Some of it is because of crazy uses of derivatives that are enabled by massive computers.

None of this was even possible when the economists were coming up with their theories of simple derivatives like futures back in the 70s. They don't understand the math they are dealing with (which is one of the things that happened in 2008).

So what was happening between the 70's and this century? See the gap in your thinking there? You are conflating two different things.

Derivatives do smooth things out, really they provide protection for those that choose so via hedging. The problems you are talking about stem from two other things. Multi-fold increases in transaction speed and misregulation (a combination of deregulation and lack of adaption of regulation) combined with some creative financial shadiness.

Derivatives (and the exercise of options) are likely a good method for pursuing a more stable long-term market for Bitcoins (by positioning those bullish and bearish on the virtual currency as competing interests), but their limited utility may make even these more sophisticated instruments speculative at best. After all, like the article says, we know what commodities are good for, we know what bonds are good for, we even mostly grasp the concept of what we get with an equity position. But Bitcoins? Not as clear-cut.

When they say 'derivatives', they are not talking about options or futures. They are talking about something like Bitcoin Swaps, or Collateralized Securitizations of Bitcoin Swap Contracts, or other massively complicated organs.

You say "we know what bonds are good for". No, we don't. If we did, then the 2008 crash would never have happened - because that entire bubble was based on the inability of the banks and regulators to put a value on Mortgage bonds (as bundled into Mortgage Securities, which were rebundled into Collateralized Debt Obligations, which were rebundled into Synthetic Collateralized Debt Obligations based on Credit Default Swaps referencing other CDOs).

That bubble was due to lack of political will [primarily in the US]. EDIT: Well 'due to' raises a philosophical argument but it was a mitigable issue and the whole of "derivatives" was not the issue.

There were countries that were only slightly affected by it, and then only via collateral damage. Countries that did not drink the "unfettered free market knows best" Koolaid.